Also on KPMG.com

The United Kingdom’s (UK’s) vote last week to Remain or Leave the European Union (EU) may have well been the country’s ‘be careful what you wish for’ moment. Having spent most of last week in London, the campaigning on the Remain side clearly articulated the downside economic risks to the UK that a Leave outcome would cause.

The head of the International Monetary Fund (IMF) publicly stated more than a month ago that a Leave outcome from the UK EU referendum would have “pretty bad to very, very bad” consequences, and she had "not seen anything that's positive" about Brexit, warning it could "lead to a technical recession".

Risk and uncertainty are now in the driving position as a consequence. We’ve already seen a significant devaluation of the British Pound against all major currencies, and the expectation is that the risk premium attached to the UK currency will remain elevated at least until the country formally withdraws from the EU. Uncertainty will negatively impact business investment, yields on government securities, the differential between lending and deposit rates for households and businesses, and increase the premium required for equity returns. All-in-all, these individually and collectively will pull down the UK's gross domestic product (GDP).

Various economists have predicted the consequence of a Brexit on UK economy will be a reduction in GDP of somewhere between -1 and -3 percent in the short term (compared to the ‘base case’ of remaining in the EU), and upwards of -4 percent over the medium term. How bad it will be will depend on the trade deals that the UK is able to negotiate with EU member states, with the ‘best’ outcome being where the UK Government is able to implement free trade agreements (FTAs) for goods and services similar to the model implemented by Norway.

The ‘worst’ outcome is one where bilateral trade arrangements occur through normal WTO arrangements, and no FTAs are reached. Her Majesty’s Treasury’s modelling shows the medium term impact on the UK GDP of these trade models ranges from, on average, about -3.8 percent to -7.5 percent. Pretty bad to very, very bad.

Implications for Australia

The implications for Australia are still being worked through, but any impact will be felt via our trade accounts. KPMG Economics have prepared preliminary forecasts on the impact of Brexit on the Australian economy.

Our ‘best case’ scenario assumes that, compared to the base case, UK GDP declines by about -3 percent between now and the transition period, and stabilises at around these levels for the medium term. The ‘worst case’ scenario is more aggressive, and assumes UK GDP is lower by about -5 percent compared to the base case. This reflects the mid-point value of the KPMG UK's analysis.

Given these scenarios, the impact on Australian GDP, as compared to the base case, is expected to be:

‘best case’ scenario = -1.0 percent lower

‘worst case’ scenario = -1.4 percent lower.

As anticipated, the primary cause of the fall in our GDP is a deterioration in our net export position, with:

exports declining between -1.2 percent and -1.7 percent over the medium term

imports rising between 0.8 percent and 1.1 percent.

Overall, however, the impact on the real rate of growth in Australia’s GDP is expected to be minor. Australia’s GDP growth starts to be affected from around FY2022, and the rate is ‘shaved’ by between -0.1 percent and -0.2 percent by FY2031.

Again, these forecasts are predicated on the UK Government implementing new trade agreements that continue to allow negotiated access to markets in the EU. Should these agreements enable freer trade than has been presumed, then the economic consequence of Brexit may be less dramatic. Conversely, if the UK gets ‘shut out’ of EU markets more than anticipated, then the consequence will be worse.

Either way, assuming the UK Government will now implement Article 50 of the Lisbon Treaty, that ‘moment’ has now come true.

Additional commentary

For further analysis, visit the KPMG UK website, which provides additional commentary and resources.